M&A Journal: What About Sprint’s Wireline Business?

Sprint Nextel (NYSE:S, news, filings) is in the news all the time these days, but almost entirely for its wireless business and the company's rather public indecisiveness over Clearwire, WiMAX, TMobile, LTE, LightSquared, etc. But there's also that pesky wireline business that nobody ever talks about much even though it contributed $5.04B in revenue and $1.09B in EBITDA in 2010. In all the speculation about Sprint's future in the soap opera of wireless networks, the fate of one of the largest international fiber and IP backbones seems to get far less than its share of attention. For instance, just what would happen to that asset if Sprint merged with T-Mobile USA and DT came on board with a big stake in the combined company and no interest in an aging fiber asset?

A year and a half ago the answer was rumored to be a merger of Sprint Wireline with another carrier in the form of some unspecified kind of joint venture, with Level 3 and Qwest being the most frequently mentioned. But Qwest will soon be part of CenturyLink, and the combined company will surely be rather busy for a while integrating what they have. Level 3 has been, like Sprint, seeking to recover a bit of lost ground over the past year. Are they now in a position to deal?

A Sprint/Level3 joint venture has never been one of my favorite combinations, however I think it is more likely now than ever in the past. Both companies have stabilized and are looking ahead now, but they have both absorbed some pretty humbling blows in the past three or four years that may have given each a rather more practical view of their own relative value. And both have very straightforward motives to make a deal:

Sprint would gain a future in wireline even while turning all its attention to wireless as it so clearly wants to. Sprint has been running the wireline business for cash while spending less capex than any other network as a percentage of revenue. They've been very successful at it thus far, but you can't do it forever. Eventually that declining revenue will hit a wall of fixed expenses, and they'll need to do something else long before they reach that point.

Level 3 would gain the scale to finally justify its debt load. Combined the two would have over $8B in revenue and nearly $2B in EBITDA. They have been trying to grow into their debt for a decade now, but the going has been rather rough over the past few years to say the least and they have made little progress organically.

A Sprint/Level3 joint venture would probably have more flexibility when it comes to financing than the possibility I have dwelt on more often over the years - Level 3 and Global Crossing. On the other hand, Sprint might not want to involve itself with Level 3's debt load even with the refinancing work that has been done, while Level 3 might not want to take on a huge new pile of declining legacy revenue when it has just recently reached the point where the vast majority of its current revenues are core.

Of course, Level 3 is not the only fish in the pond other than Qwest. AT&T and Verizon would obviously hit regulatory issues and care more about wireless nowadays anyway, so they seem unlikely. One could posit Global Crossing or TW Telecom or even (shudder) XO as a possible place for Sprint to leverage its wireline assets in a joint venture. But TW Telecom lacks motive and also a national intercity fiber backbone (Sprint's is too old now), Global Crossing lacks US metro coverage (and hence fewer available synergies), and XO has Icahn ('nuff said). But they could always wait a year for CenturyLink/Qwest too.

In the end, it all comes down to price though, and in the past they Sprint and Level 3 not been able to agree on one. I still doubt they could hammer out a deal now, but I'll bet they're closer now than a few years ago. And I think it's more likely to benefit shareholders on both sides than the rumored deal for T-Mobile USA.

Also, what do you mean by “aging fiber asset” ? Is Sprint’s fiber plant built around fiber so old it can’t be upgraded with new lasers ? Or is it simply that it will be un-cheap to upgrade parts of their network ? Is there a possibility that Level 3’s backbones might tie into Sprint’s last miles for a cost effective speed bump-up and coverage expansion ?

My apologies – I didn’t spot the earlier post until after I posted my comment. So yes, it will be un-cheap and possibly not upgradable. On the subject of the direct-buried cable is the ROW leased or owned by Sprint ? If it’s owned that is a substantial carrot for potential partners.

Well, no extensive footprint is homogeneous. But I know that some of Sprint’s fiber plant is so old it was direct buried. They haven’t spent on such things in quite some time, and certainly haven’t been going around trialing 100G gear that I know of either – I suspect much of their fiber is not up to the task. But I could be wrong, they might have some newer fiber I don’t know about.

Rob, I seem to remember there were some additions and upgrades during the dotbomb era. Any way you could look into this a bit? Specifically, I’d like to know what parts, if any, were built out in the last 15 years.

i think that lvlt has made some bad mistakes in their original business plan. the theory they operated on was that bandwidth is a technical commodity and that the telecom business is going to be like the computer business and be horizontal in its formation. warren buffett has said that owning a commodity producer is only valuable when you are in a shortage of that commodity. well its obvious we havent had a shortage of bandwith yet based on lvlt’s ebitda. so lvlt’s premise to date of being the lowest cost producer of bandwidth has not worked for shareholders and they are neither oblivious or idle to that mistake. not controlling the end user (cell phones, enterprise etc) has been a huge mistake as well for lvlt as t and vz continue to buy their customer and not share the bandwidth with lvlt. to DATE, telecom has been end to end and not horizontal business.

i typed all of that to get to my point here, do you think buying global crossing would cause the supply demand equation in bandwidth to finally go to a “shortage”? if so then i think lvlt could buy them and still realize JC’s dream of a shortage or a change in supply and demand. If you dont think a shortage is ever a possibility then the solution has to be some venture with sprint where you have an end user who cant leave you when t and vz come calling.

in simpler terms the question is whats more valuable, control the end user or consolidate the industry and bet on your ability to control supply and demand.

Shortages in bandwidth can only ever be a localized problem. On major intercity routes it’s not ever going to happen, but in the metro and on less popular routes it already does. Bandwidth ‘supply’ is not a lumpable commodity, so you can never control ‘it’ you can only control some of ‘them’. That’s why Level 3’s metro footprint is the key to their potential in today’s market. Scale is the key right now for Level 3, and I think either GLBC or Sprint would give them that.

rob, if there was never going to be a shortage on the intercity routes then crowes vision was just wrong to own only a long haul network (before 2006). i am not sure i agree with your never comment on long haul. why never?

Crowe’s original mid-90’s vision as you describe it took a torpedo amidships with DWDM and never recovered. But the fact that they built tons of metro loops back then too illustrates they weren’t completely wrong – they are still here after all.

The intercity supply imbalance is why they started buying metro fiber in 2006. The piece of the original vision that still lives is upgradability – if advances in fiber are enough to make their conduits worthwhile then we can talk shortage again. But then there is Allied Fiber…

I gotta agree with you on that Rob. I think TFT touched on the issue .. and it’s the same issue we’ve all been aware of for .. well .. ever. The edge owners and last mile have too many advantages, and there seems to be no easy way out of this puzzle for the backbones. Until this gets solved .. either through tech or legislation (doubtful) everybody suffers except the RBOCs, MSO/Cable etc.

How much of that ebitda is TWC which has announced they would be moving off of Sprint wireline. That revenue is probably worth less than the old SBC contract. Secondly for the remaining revenue, and much more more importantly, how does CTL/Q or LVLT get Sprint incented toward a desirable end of moving over as much as that ebitda as possible(the CLWR structure seemed always to be in play).

Either way(and I have alluded to on this board b4), the multiple you may pay for those Sprint cash flows might be ~half(?!?!) of the industry average given the risk involved of that transfer as well as the likely poor Sprint customer satisfaction with an archaic backbone and the competitive response that has already brought into the Sprint territories which put the remaining cash flows at risk?

Besides all this YAKKING, is there someone here who has “done the math”? Jim Crowe commands you to “doing the math.” Long ago, Gates did it to envision this network that Scott’s crew built for that purpose. Give me a new “Indian Mathematician” who will debunk this ten year old “Suria Ghoul” argument which was embedded in slicing and dicing bandwidth via DWDM, or give me Jim Crowe’s head and an OPERATOR moving towards “end to end” customer control. Before discounting Crowe; however, these aren’t stupid people and they know the math. It doesn’t include having “white mice” flow through their pipes as some silly analysts might have said in the past. The answer of supply constraints was partially contained in a CDN key note speech he gave for Dan Rayburn in 2005.

Thanks Rob. I was going to let him know that if he can’t take the good with the bad along with the ugly, then he is just a smart a** punk, and you might even allow those “Gang Bangers” to show up here again to take care of him, like they tried doing to me. “FEAR NO MAN” or evil will consume your house.

I think Toddyboy predicted a Crowe buy of stock with his own money in February, 2011. How did that work out? LOL!

With Level 3 standalone(Forget needing GX) ebitda on the verge of passing Sprint Wireline Ebitda. You can’t help to think ahead to the next hurdles for this passing of the torch in terms of the following questions: How long does it take to do the following:
(1) Level 3 Stock Price > Sprint Stock Price
(2) Level 3 Mkt Cap > Sprint Mkt Cap
(3) Level 3 Ebitda > Sprint Ebitda

Taking it a bit further for this group in terms of specifics
(A) The assumption that L3 wireline ebitda > Sprint Wireline Ebitda.

(A) Sprint called out TWC as costing them $150M in wireline ebitda for the year. Back 8 months ago when I followed TWC a bit more closely they said it would take a few years to bring the whole thing back in house. So if 1.09B in ebitda minus 150 is actually now $4M below L3’s standalone ebitda estimate I saw last(Raymond James). Future TWC ebitda losses aside, the outlooks of those respective ebitda numbers couldn’t be more different which leads directly into the next point of eclipse.

(#2 Mkt Cap) Assuming L3 sees the ebitda forecasted in their S4 {L3 + GC} + the Synergies L3 is looking at $2B for 2013(Neutral rated RJ is actually ahead of the S4 runrate given their $1.6B est for 2012). I would argue that the L3 growth rate looks light on those numbers but taken for what they are and using some multiple degradation from this year back to 10x backing out 6.3B in net debt is 13.7B in mkt cap, greater than Sprint today at 12.2B.

(#1 – Stock Price) Using that 13.7B mkt cap, and 3.24B diluted L3 shares you also get a stock price of $4.22 greater than the Sprint stock price today. Sprint may turn it around but that was never a good bet before.

Given the Sprint share price decline – the market may not have to give L3 any higher value b/c Sprint’s stock could be into the high 1’s by next month if these stories about funding deficiencies keep popping up.

Sprint wireline ebitda ests continue to erode even from these August comments. I do not think they could get $5B for that asset. I would have agreed with Todd that we we were talking a 5x multiple on the ex-twc ebitda though the run-off in that business makes me believe that using a multiple would be inappropriate. Here is what downside might look like….

JPM ests is 702M for Sprint 2012 wireline ebitda headed to 635 the following year, 575, 422, 421 for the ensuing 3 years. So maybe if 425M in ebitda is true sustainability (though ex-growth)then you get an ex-growth multiple. I don’t think you will get the multiple XOHO’s board “determined” for us at 5.6x but it should be used by any buyer as a basis for comparison. So at 6x sustainable, non-growth ebitda according to JPM – you are looking at $2.5B. Now the idea that it would go for half of Rob’s estimate may seem like a stretch but when you think of the age of that asset, the desperate nature of the seller, the resourced starved nature of it as well as the messiness associated with divorcing it from the sinking ship that is Sprint – I think real bids in this financing market will look a lot more like the downside case then the “ace up their sleeve” case.

Could be, my main point was from the perspective of Sprint – which probably would put it up for sale with a different perspective on its value. Its hard to tell just where sustainable EBITDA really is for the business at this point, one would obviously have to do some major DD.

Just for an update here. JPMorgan in their June upgrade piece has Sprint holding on to 451M in ebitda next year before falling to 394 and then 379 before stabilizing at 350M – about 75M less than what was estimated above just last Fall.

JPMorgan doesn’t ascribe a discreet fair value multiple to wireline. However, M. Lynch does at 5x ebitda. Whether Sprint would want a higher multiple as someone else may be able to better retain those falling profits is likely but a $2Bn valuation today for that unit when it would have to be disentangled from Sprint Corp seems like a stretch on the aforementioned math.

At this point, it seems difficult to envision a scenario where the creditors would allow this to happen ahead of the integration of CDMA/iDen next year but who knows what ‘sustainable’ EBITDA will look like by then.